Selloff an overhang

Updated: Dec 3 2012, 06:09am hrs
Weak execution record and rich valuation cloud positives

Stake divestment to pressure stock; mines are long-term. We see government divestment of its 9.5% stake in NTPC as a potential stock overhang given the weak execution at NTPC, its rich valuation and that re-allocation of three coal-mines is only a long-term catalyst at best.

A potential hike in the float to 25% (15.5%) could pressure the shares and has been one reason for our Underperform rating. The government is working to hike LIC's investment limit to 30% vs 10% as LIC, which bought most of the qualified institutional placement (QIP) in NTPCs last follow-on public offer (FPO) already owns over 6%.

The NTPC stock has underperformed the market by 18% YTD (year-to-date) despite it being a consensus Buy (55% brokers).

We reiterate our non-consensus Underperform (13% brokers), as its slow growth (9% till '17e) on poor execution may de-rate its expensive regulated utility multiples (1.6x P/BVprice-to-book value) esp. given that a peaked FY14e (estimates) RoE (return on equity) of 13.8%, negative FCF (free cash flow) and lower yield (3% vs SJVN's 5%), could cap upside apart from government divestment.

Govt to divest 9.5% stake; Will mine catalyst work NTPCs last FPO in Feb10 was subscribed by LIC, which bought 50% of the offer (2.5% of 5% offered) i.e. the entire QIB portion at R209/share (vs floor at R201). Post-FPO, LIC sold 39% in one month. The stock is now trading at 22% below the LIC FPO bid price. To create catalysts, government announced the return of three cancelled coal mines with reserves of 826mt ahead of divestment. This is only a long term trigger as these mines are unlikely start meaningful production before FY15. Meanwhile, EPS growth is likely to slow materially over FY14-17e on poor execution, fuel issues and delay in equipment orders.

Negative catalysts are: (i) delay in capexmanagement almost halved NTPC FY13-17e group new capacity, which adds to execution delays by its Russian vendors & bulk order, impacting its PAT/RoE (profit after tax/return on equity) growth, (ii) fuel shortages impacting incentives/RoE, and (iii) rich valuation. Pick-up in power/coal capex are positive catalysts.

Price objective: Our price objective of R153 for NTPC is based on DCF (discounted cash flow) based valuation. We have assumed WACC (weighted average cost of capital) of 10.3%.

Downside risks: (i) delay in project execution due to infrastructure bottlenecks & working challenges with new vendors,

(ii) risk of fuel supply to existing/ new plants, (iii) potential cut in RoE with likely improved demand-supply gap of power, (iv) potential entry into unrelated businesses (boilers) and (v) increased competition from the private sector.

Upside risks: A pick-up in capex/coal capex and higher than 15.5% RoE on gross-up of income tax.